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After a strong first half to the year, positive economic growth continued into July. Risk assets were up across the board and volatility was notably muted. Second quarter earnings came in strong with both revenue and earnings surprises accelerating from already strong levels, helped by a weaker US dollar and depressed oil prices. On the political front, the Senate’s failure to pass a healthcare bill cast a shadow on the “Trump trade”, bringing forth concerns on whether meaningful tax and regulatory reform can be accomplished. However, this failure may serve as a catalyst for other pro-growth initiatives, such as tax reform, to be pushed through in the near future. Overall economic data leans positive and we expect markets will continue to trend upward over the near term.

The S&P 500 was up 2.1% in July and reached a record high mid-month, stemming from many large corporations reporting stronger than expected second quarter earnings. All sectors posted positive returns with the largest outperformers being telecom (+6.4%) and technology (+4.3%). Large cap stocks outperformed mid cap and small cap stocks and lead year to date. Growth outperformed value and leads by a large margin year to date.

Developed international equities outperformed domestic equities, returning 2.9% for the month. Improving fundamentals and increased investor sentiment in both the Eurozone and Japan helped spur continued positive economic growth. Both regions remain heavily reliant on central bank stimulus programs and speculation has begun on whether the European Central Bank or Bank of Japan will begin easing in the near future. Emerging markets rallied, gaining 6.0% for July, with all BRIC countries posting positive returns. Brazil was up over 11%, stemming from initial failed corruption allegations of the country’s president, Michel Temer.

Fixed income markets were quiet during the month. The July Fed meeting was relatively uneventful with an expected announcement of no changes to interest rates. The Bloomberg Barclays US Aggregate Index returned 0.4% with all fixed income sectors posting positive returns. The 10 Year Treasury yield ended at 2.3%, relatively unchanged from the beginning of the month. High yield spreads contracted an additional 12 basis points. Municipals were up 0.8%, outperforming taxable counterparts.

We remain positive on risk assets over the intermediate-term, although we acknowledge we are in the later innings of the bull market and the second half of the business cycle. While this cycle has been longer in duration compared to history, the recovery we have experienced has been muted. While our macro outlook is biased in favor of the positives and recession is not our base case, especially considering the potential of reflationary policies from the new administration, the risks must not be ignored.

We find a number of factors supportive of the economy and markets over the near term.

Reflationary fiscal policies: Despite a rocky start, we still expect fiscal policy expansion out of the Trump Administration, potentially including some combination of tax cuts, repatriation of foreign sourced profits, increased infrastructure and defense spending, and a more benign regulatory environment.

Global growth improving: U.S. economic growth remains moderate and there is evidence growth outside of the U.S., in both developed and emerging markets, is improving. Earnings growth has improved across markets as well.

Business confidence has increased: Measures like CEO Confidence and NFIB Small Business Optimism have improved since the election. This typically leads to additional project spending and hiring, which should boost growth.

However, risks facing the economy and markets remain, including:

Administration unknowns: While the upcoming administration’s policies are still being viewed favorably by investors, uncertainties remain. The market may be too optimistic that all of the pro-growth policies anticipated will come to fruition. The Administration has quickly shifted from healthcare to tax reform legislation. We are unsure how Trump’s trade policies will develop, and there is the possibility for geopolitical missteps.

Risk of policy mistake: While global growth has improved, it is important that central banks do not move to tighten too early. The Federal Reserve has begun to normalize monetary policy, but has room to be patient given muted levels of inflation. The tone of the ECB has begun to shift slightly more hawkish.

The technical backdrop of the market is favorable, credit conditions are supportive, and we have seen acceleration in economic growth. So far Trump’s policies are being seen as pro-growth, and investor confidence is elevated. The onset of new policies under the Trump administration and actions of central banks may lead to higher volatility, but our view on risk assets remains positive over the intermediate term. Higher volatility can lead to attractive pockets of opportunity we can take advantage of as active managers.

Brinker Capital Market Barometer

Source: Brinker Capital. Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. Indices are unmanaged and an investor cannot invest directly in an index. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. S&P 500: An index consisting of 500 stocks chosen for market size, liquidity and industry grouping, among other factors. The S&P 500 is designed to be a leading indicator of U.S. equities and is meant to reflect the risk/return characteristics of the large-cap universe. Companies included in the Index are selected by the S&P Index Committee, a team of analysts and economists at Standard & Poor’s. Bloomberg Barclays U.S. Aggregate: A market capitalization-weighted index, maintained by Bloomberg Barclays, and is often used to represent investment grade bonds being traded in United States. Brinker Capital Inc. and Santander Investment Services are independent entities and neither is the agent of the other.

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, Inc., a Registered Investment Advisor.

Foreign securities are more volatile, harder to price and less liquid than U.S. securities; and are subject to different accounting and regulatory standards, and political and economic risks. These risks are enhanced in emerging markets countries.

Frontier markets still offer investors the potential for higher returns and lower correlation within broadly diversified portfolios. Although emerging and frontier markets both offer younger populations and higher economic growth potential relative to developed markets, there are also key differences that currently favor frontier markets.

Frontier markets include a variety of countries that, in many cases, are more tied to domestic factors as opposed to global growth. Countries in Sub-Saharan Africa, such as Kenya and Nigeria, and in South Asia, such as Vietnam and Bangladesh, offer potential investment opportunities. Several of these markets are enacting structural reform and attracting foreign direct investment to improve economic growth prospects. While depressed oil prices have an impact on growth in Middle East economies, such as Oman and Qatar, these countries also boast higher incomes and strong population growth rates.

Source: MSCI, Blackrock

Source: MSCI, Blackrock

In contrast, emerging markets are more of a mixed bag. The larger BRICK economies (Brazil, Russia, India, China, South Korea) within emerging markets contain a spectrum of moderate growth to stagnation along with banking sectors hobbled by large and rising bad credit. Depressed commodity prices directly hurt Brazil and Russia, while a capacity glut in basic materials impacts bank loans in China and India. The question of “whither the BRICKs” is vital to the direction of emerging markets given they comprise over half of the index.[1]

Investing in frontier markets provides more exposure to domestic growth sectors whereas emerging markets are more geared toward industries influenced by global commodity exports. Domestic sectors account for three out of every four dollars in frontier markets, while they comprise only one out of every two dollars in emerging markets. Industry sectors related to global trends (in many cases commodities) comprise nearly half of emerging market companies but only a quarter of frontier markets.[2]

Frontier markets only comprise less than 3% of the world’s total market capitalization.[3] Coupled with potentially faster growth relative to the developed world, further structural reform could propel further growth in capital markets.

Superior population growth is one supportive factor. Median population growth of 1.5% in Frontier markets exceeds growth in both developed and emerging markets.

2014 Median Compound Annual Population Growth

Frontier Markets

1.5%

Developed Markets

0.7%

Emerging Markets

0.9%

Source: World Bank and Brinker Capital

A growing variety of funds and ETFs have come to market and allowed greater access to investing in frontier markets in recent years. Nonetheless, frontier markets continue to offer potential benefits to diversifying investment portfolios. Even over the last five years, frontier markets still show lower correlation to broad equity indices (and even lower relative to emerging markets).

The views expressed are those of Brinker Capital and are not intended as investment advice or recommendation. For informational purposes only. Holdings are subject to change. Brinker Capital, a Registered Investment Advisor.

Despite geopolitical tensions in Russia and the Middle East, the end of the Federal Reserve’s quantitative easing program, weakness in growth abroad, and a significant decline in oil prices, U.S. large cap equities posted solid double-digit gains in 2014. International equity markets lagged U.S. markets, and the spread was exacerbated by the major strength in the U.S. dollar. Despite consensus calling for higher interest rates in 2014, yields fell, helping long-term Treasuries deliver outsized returns of more than 25%. The weakness in energy prices weighed on markets in the fourth quarter, with crude oil prices falling by almost 50%, the type of move we last saw in 2008. However, it wasn’t enough to prevent the S&P 500 from hitting all-time highs again in December. Volatility remained relatively low throughout the year. We did not see more than three consecutive down days for the S&P 500, the fewest on record (Source: Ned Davis Research).

In the U.S., the technology and healthcare sectors were the largest contributors to the S&P 500 return; however, utilities posted the biggest return, gaining more than 28%. Large caps significantly outperformed small caps for the year, despite a big fourth quarter for small caps. The spread between the large cap Russell 1000 Index and small cap Russell 2000 Index was 760 basis points. Growth outperformed value in large caps and small caps, but value outperformed in mid caps due to the strong performance of REITs.

U.S. equities outperformed the rest of the world in 2014. The S&P 500 Index led the MSCI EAFE Index by more than 1,800 basis points, the widest gap since 1997. In local terms, international developed markets were positive, but the strength of the dollar pushed returns negative for U.S. investors. Emerging markets led developed international markets, but results were mixed. Strength in India and China was offset by weakness in Brazil and Russia.

As the Fed continued to taper bond purchases and eventually end quantitative easing in the fourth quarter, expectations were for interest rates to move higher. We experienced the opposite; the yield on the 10-year U.S. Treasury note fell 80 basis points during the year, from 3.0% to 2.2%. Despite a pick-up in economic growth, inflation expectations moved lower. In addition, U.S. sovereign yields still look attractive relative to the rest of the developed world. As a result of the move lower in rates, duration outperformed credit within fixed income. All sectors delivered positive returns for the year, including high-yield credit, which sold off significantly in the fourth quarter due to its meaningful exposure to energy credits.

Our macro outlook remains unchanged. When weighing the positives and the risks, we continue to believe the balance is shifted in favor of the positives over the intermediate term and the global macro backdrop is constructive for risk assets. As a result our strategic portfolios are positioned with an overweight to overall risk. A number of factors should support the economy and markets over the intermediate term.

Global monetary policy accommodation: We anticipate the Fed beginning to raise rates in mid-2015, but at a measured pace as inflation remains contained. The ECB is expected to take even more aggressive action to support the European economy, and the Bank of Japan’s aggressive easing program continues.

Pickup in U.S. growth: Economic growth improved in the second half of 2014. A combination of strengthening labor markets and lower oil prices are likely to provide the stimulus for stronger-than-expected economic growth.

Inflation tame: Inflation in the U.S. remains below the Fed’s 2% target, and inflation expectations have been falling. Outside the U.S., deflationary pressures are rising.

U.S. companies remain in solid shape: U.S. companies have solid balance sheets that are flush with cash. Earnings growth has been solid and margins have been resilient.

Less uncertainty in Washington: After serving as a major uncertainty over the last few years, Washington has done little damage so far this year. Government spending will shift to a contributor to GDP growth in 2015 after years of fiscal drag.

Lower energy prices help consumer: Lower energy prices should benefit the consumer who will now have more disposable income.

However, risks facing the economy and markets remain, including:

Timing/impact of Fed tightening: QE ended without a major impact, so concern has shifted to the timing of the Fed’s first interest rate hike. While economic growth has picked up and the labor market has shown steady improvement, inflation measures and inflation expectations remain contained, which should provide the Fed more runway.

Slower global growth; deflationary pressures: While growth in the U.S. has picked up, growth outside the U.S. is decidedly weaker. The Eurozone is flirting with recession, and Japan is struggling to create real growth, while both are also facing deflationary pressures. Growth in emerging economies has slowed as well.

Geopolitical risks: The geopolitical impact of the significant drop in oil prices, as well as issues in the Middle East and Russia, could cause short-term volatility.

Significantly lower oil prices destabilizes global economy: While lower oil prices benefit consumers, significantly lower oil prices for a meaningful period of time are not only negative for the earnings of energy companies, but could put pressure on oil dependent countries, as well as impact the shale revolution in the U.S.

While valuations are close to long-term averages, investor sentiment is in neutral territory, the trend is still positive, and the macro backdrop leans favorable, so we remain positive on equities. In addition, seasonality and the election cycle are in our favor. The fourth quarter tends to be bullish for equities, as well as the 12-month period following mid-term elections. However, we expect higher levels of volatility in 2015.

Our portfolios are positioned to take advantage of continued strength in risk assets, and we continue to emphasize high-conviction opportunities within asset classes, as well as strategies that can exploit market inefficiencies.

Asset Class

Outlook

Comments

U.S. Equity

+

Quality bias; overweight vs. Intl

Intl Equity

+

Country specific

Fixed Income

+/-

Actively managed

Absolute Return

+

Benefit from higher volatility

Real Assets

+/-

Oil stabilizes in 2H15

Private Equity

+

Later in cycle

Source: Brinker Capital

Views expressed are for informational purposes only. Holdings subject to change. Not all asset classes referenced in this material may be represented in your portfolio. All investments involve risk including loss of principal. Fixed income investments are subject to interest rate and credit risk. Foreign securities involve additional risks, including foreign currency changes, political risks, foreign taxes, and different methods of accounting and financial reporting. Past performance is not a guarantee of similar future results. An investor cannot invest directly in an index.

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Brinker Capital provides this communication as a matter of general information. Portfolio managers at Brinker Capital make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.